Market would prefer a CRR cut

The economic indicators might not give reason for the Reserve Bank of India (RBI) to cut rates in its second quarter review of the monetary and credit policy on Tuesday but bankers and economists said an urge to support the government's recent reform measures could prompt the central bank to do so.

However, most experts said a cut in banks' cash reserve ratio (CRR) was the best option before RBI for supporting system liquidity. In the mid-quarter review, RBI had reduced CRR by 25 basis points (bps), in anticipation of the tighter liquidity conditions banks might have to face at the onset of the festive season

RBI's task has been made more difficult by Finance Minister P Chidambaram's recent assertions that it would be good if fiscal policy steps encourage the central bank to take monetary policy action to lower interest rates. RBl has held the policy rate or the repo rate (at which it lends to banks) at eight per cent since April.

Leif Eskesen, chief economist for India and Asean at HSBC, said: "There is admittedly a risk that RBI might cut the policy rate in response to the reform measures announced by the government. However, while the announced measures are necessary to create room for rate cuts, we do not see these as sufficient by themselves to trigger a cut."

Most of those spoken to felt while a policy rate cut could boost business sentiment, it might not result in effective monetary policy transmission. "We feel the governor may be reluctant to cut rates with inflation likely to persist at 7.5-8 per cent levels till December. In any case, RBI rate cuts might not translate into lending rate cuts till liquidity improves," said Indranil Sen Gupta, India economist at Bank of America-Merrill Lynch.

Last month, banks had cut lending rates in select segments to push retail credit growth. Comfortable liquidity might help lenders to further lower interest rates. "The cost of deposits needs to come down. If there is a cut in the CRR, it will help banks to cut deposit rates," said B A Prabhakar, chairman and managing director of Andhra Bank. He added the bank would decide on a base rate cut if RBI aided liquidity.

Echoing the need for easing CRR, Shubhalakshmi Panse, chairman and managing director, Allahabad Bank, said liquidity was tight. Growth was looking up in the agriculture and industrial sectors and banks would need funds to meet credit demand. A 50 bps CRR cut will release more resources. It would nudge public sector banks to reduce lending rates by at least 25 bps, she felt.

While repo borrowings have shot up to Rs 1 lakh crore lately, the tightness is not yet reflected sharply in money market rates. This is mainly due to the excess securities held by banks under the statutory liquidity ratio, which should be a minimum 23 per cent of net demand and time liabilities.

Other than the policy rate decision, RBI is expected to roll out final norms for banking licences, liquidity under Basel-III rules and debt restructuring.